Double-Digit Yield with Protection

03/16/2011 12:15 pm EST

Focus: ETFS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

This heavily discounted closed-end fund supplements its blue-chip holdings with put options, writes Richard Lehmann of the Forbes/ISA Closed-End Fund & ETF Report.

The market seems to be careening between “risk on” and “risk off” scenarios.

Whenever there is a global shock of some type, the market runs for cover and buys Treasuries, US dollars, and gold. When things look a bit calmer, funds flow back into stocks and out of other asset classes.

This seesaw looks to continue for a while, unless there is another oil shock. If oil prices get much over $100 a barrel, the economic recovery will stall since higher gasoline prices will crimp consumption of other consumer goods.

High food prices aren’t helping either, for the same reasons. US consumers spend less of their total income on these two items than their counterparts in the developing world, where higher food prices will cause social disruption.

Covered-call funds typically give investors the advantage of producing income in flat markets, but don’t do well in quickly rising or falling markets. We like the idea that gently rising or falling markets can be profitable for such funds.

One such fund we’ve previously recommended is the Eaton Vance Risk-Managed Diversified Equity Income (ETJ). Its advantage is in the risk-managed part of its title. The fund sells calls like most covered-call funds, but also buys puts to guard against a market decline.

Today the fund trades at a steep discount of 9.5%, and offers a yield of 10.1%. We think their new policy of buying protective put spreads is a prudent strategy, although it may have scared off some current holders, depressing the price.

The largest holdings are in information technology at 18.04%, financials at 15.58%, health care at 11.82% and consumer staples at 11.45%.

[In terms of individual stocks, the fund is most heavily invested in Apple (AAPL), JP Morgan Chase (JPM), ExxonMobil (XOM), Oracle (ORCL) and UnitedHealth (UNH)—Editor.]  

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